Sometimes great advice needs greater follow-through
by Dick Weber, MBA, CLU, AEP (Distinguished)Mr. Weber is a past-president of the Society of Financial Service Professionals and is a fee-only Insurance Fiduciary consulting with clients and financial institutions. For the past decade, Dick has provided his consulting services to many carriers, including The Guardian Life Insurance Company of America. He makes recommendations based upon his relationships with the companies and the integrity of the products and people that back them. He can be reached at [email protected]
Financial advisors whether fee-only planners or commissioned life insurance producers are not recommending/selling enough life insurance to their clients!
While more families are buying life insurance, 30% of households remain uninsured. Among those who do have life insurance, the average amount of insurance has dropped to just 3 times annual income – down from 3.5 times income in 2010, according to a 2016 Household Trends in Life Insurance Ownership study conducted by LIMRA.
70 percent of U.S. households with children under 18 would have trouble meeting everyday living expenses within a few months if a primary wage earner were to die today. Four-in-10 households with children under 18 say they would immediately have trouble meeting everyday living expenses. Source: LIMRA Household Trends in U.S. Life Insurance Ownership, 2010.
Most families have 100 percent replacement value on their homes (because their lender requires it) yet often insure less than 10 percent of their most valuable asset their human life value as a reflection of the ability to earn a living and support a family!
Invest the Difference… but invest it in what?
It’s easy to get hung up on the distraction of “buy term and invest the difference,” but the reality is that few families have anywhere near the recommended minimum of 10 times earnings in the form of any kind of life insurance policy.
So let’s resolve this right here and right now: What we need to be talking about is fulfilling the total amount of protection our clients need and at least initially that’s probably going to start with level premium term insurance.
So if you read no further, your take-away from this 50-year veteran of the life insurance industry indeed a fee-only Insurance FiduciarySM is he’s saying: “Buy Term!”
The first priority we discuss with our clients is figuring out how much protection is appropriate in a family or business situation, and making sure to acquire protection first. For an attorney in her early 30’s currently earning $150,000, her lifetime income could approach $20 million, meaning her ability to earn an income is by far her largest asset. She doesn’t need to insure all of that, but probably needs $2.5 to $3.5 million of instant capital to replace that income on behalf of a family who is depending on her for the essentials of a roof over their heads, nourishing meals (and someone to cook those meals) and allowances and vacations and movie nights and college tuitions and weddings. And retirement income for the surviving spouse.
And since she’s probably burdened with at least $300,000 or more in college and law school loans to repay, fulfilling her protection need is indeed likely to be with term life insurance.
Yet we’re not buying into the financial evangelists’ generalized recommendation to “… buy term and invest the difference (BTID).” This financial “wisdom” is based on an assumption that a permanent policy is nothing more than an over-priced, under-performing savings account which, as the rant winds down, “you can easily manage on your own for far less money and far greater benefit!” Further, it’s based on the assumption that life insurance won’t be needed after the kids leave home.
Following the advice… but only for so long
Admittedly it’s a compelling argument. Certainly you should be able to invest better than an insurance company and you can save all that profit and commissions! And just why would you want protection once you shift from income based on work to income based on a portfolio of investments?
Yet to our knowledge those who follow the advice rarely follow through for more than a year or two at most! In my experience:
- The failure to carry out the “invest the difference” part is understandable. There are simply too many other priorities grabbing our attention for “the difference.” Think “digital bling!” – and
- There’s no “invoice” to remind us to take action – and
- It requires discipline and investment attention few of us actually have – and
- It almost always ends up with a 20-year term policy expiring with no side-fund and a protection need turning out to last more than the original 20 years.
Advising the 32 Year Old Client
At the age of 32 when answering the question, “how long do you think you’ll need life insurance,” we can rarely foresee all the changes our lives will take. So if you’re going to BTID, you need to buy just the right duration of term since, for example, the 21st premium on a 20-year policy is typically 15 to 20 times as high as the last guaranteed premium on the policy, and it progressively increases every year thereafter.
Let’s assume our 32-year old attorney client is the one in a thousand who will “stay the course” with BTID. What does it require in the way of return to beat a participating whole life policy?
First, ignoring you’d typically pay income taxes along the way for the “invest the difference” fund beginning at age 32, you would have to earn north of 7.25 percent each and every year, just to have the same financial result at life expectancy as can be attained with a quality whole life policy! Taking a 30 percent marginal tax bracket into account, that comes out to a need to invest and earn 10.35 percent, not as an average, but each and every year.
“But I won’t need life insurance once the kids are out of the house, or certainly not once we’re retired. So you’re driving the analysis way too far into the future.”
While a 32-year old ramping up to a long and prosperous career cannot reasonably see clearly into the future of retirement, financial professionals know the hazard of working hard and investing for that last third of our lives with the possibility of drawing down equities at the outset of a downward-spiraling stock market. The untimely movement of the natural undulations of equities and interest rates can improve or devastate a retirement income distribution plan.
We use a “lifetime need and use” inquiry through which we take our clients. In addition to aligning the client’s risk tolerance with appropriate styles of life insurance, including term, we want to know the extent to which the protection need may later in life transform into other useful aspects as an uncorrelated asset class.
Term life insurance is the logical solution for a relatively short protection need. But what Baby Boomers have discovered (and likely true for the following generations as well) is that after the protection need has passed, the kinds of life insurance designed to be affordable and useful for a lifetime can manage those future stock market ups and downs better than any other asset class.
The Whole Story
To the extent that whole life is an asset uncorrelated to the fluctuations of interest rates and equity markets, this consideration may ultimately be the deciding factor for whole life, even if a more aggressive style of policy such as IUL could be indicated from risk tolerance,
With whole life’s locked-in cash values and previously applied dividends1 (typically to paid-up additions), participating whole life is unique in its ability to protect what otherwise could be a permanent loss of value when forced to take income from a declining stock market. Incidentally, some risk tolerant clients may wonder if there is a middle-ground to have whole life’s solid guarantees2 while at the same time having some upside potential. Guardian Life, has been able to create the best of both worlds – embedding an index feature on a whole life chassis as a means to create more flexibility and potential opportunity.
Consider this example:
Having invested diligently throughout her working years, a client retires on 1/1/2000 with an accumulated $1 million in her retirement plans from which she planned to withdraw an aggressive $75,000 a year. With the advantage of hindsight, we know that starting retirement at the outset of 2000 – and withdrawing during two major downturns in the market in nine years – her portfolio would be devastated, and she would run out of principal by 2011.
Had she separately begun providing protection for her family in a whole life policy when she was 32, a well-matured policy would have given her the option to withdraw/borrow3 $50,000 a year between 2000 and 2002 and again in 2008 (remember, because policy loans aren’t subject to income tax,4 she can withdraw/borrow less) – her draw-down of her retirement assets will last years longer than if she hadn’t had the foresight to include an uncorrelated asset from which to provide income while allowing time for “the markets” to recover. And she will have a substantial additional asset in the form of a lifetime death benefit for her surviving spouse or children.
Answering “what’s the best kind of policy for me?” can be more complicated than an off-handed recommendation from a financial evangelist who is not taking your client’s needs, resources, long-term view, and risk tolerance into account. Taking a longer view of how a life insurance policy can evolve into different valuable uses over time, first as protection and later as an uncorrelated asset, you may be able to uniquely forestall an untimely problem with sequence of returns. Whether the advisor has years of insurance experience or not, digging below the surface of financial clichés is the best way to demonstrate our value as professional advisors. ◊
THIS MATERIAL IS FOR INTERNAL AND PRODUCER USE ONLY. As currently promulgated by the DOL Fiduciary Rule, any and all recommendations made could trigger “Fiduciary” status. As a “Fiduciary” you may need to satisfy stringent DOL threshold requirements and obligations set forth under PTE 84-24.
1. Dividends are not guaranteed. They are declared annually by Guardian’s Board of Directors.
2. All whole life insurance policy guarantees are subject to the timely payment of all required premiums and the claims paying ability of the issuing insurance company. Policy loans and withdrawals affect the guarantees by reducing the policy’s death benefit and cash values.
3. Policy benefits are reduced by any outstanding loan or loan interest and/or withdrawals. Dividends, if any, are affected by policy loans and loan interest. Withdrawals above the cost basis may result in taxable ordinary income. If the policy lapses, or is surrendered, any outstanding loans considered gain in the policy may be subject to ordinary income taxes. If the policy is a Modified Endowment Contract (MEC), loans are treated like withdrawals, but as gain first, subject to ordinary income taxes. If the policy owner is under 59 ½, any taxable withdrawal may also be subject to a 10% federal tax penalty.
4. Guardian, its subsidiaries, agents, and employees do not provide tax, legal, or accounting advice.